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MPs, Minister debate Connaught fund failure

Posted on May 9, 2014

Members of Parliament and the newly appointed Economic Secretary to the Treasury, Andrea Leadsom, yesterday debated the failure of the Connaught Income Fund and the roles of Capita plc and the Financial Conduct (previously Services) Authority in its failure.

Vale of Glamorgan MP Alun Cairns, who leads the informal All-Party Parliamentary Group (APPG) and called the debate, helped by interventions from a number of colleagues, ably identified the central failings of Capita that enabled investors’ money to be lost – namely the misleadingly inaccurate information memorandum, the absence of effective systems and controls for the operation of the Fund and, perhaps worst of all, its decision to conceal from investors, IFAs and the regulator the many material concerns that it became aware of about the promotion, operation and risks associated with the Fund that culminated in its decision to terminate its role as Operator.

The speech and interventions also hinted at one of investors’ long-standing concerns, namely whether their losses in the Fund could have been prevented or much reduced by more effective interventions by the regulator, the FSA/FCA.

Ms Leadsom then responded on behalf of the Treasury. She began by mentioning that she has several constituents who have lost large sums of money as a result of the Fund’s failure. We at the Action Group would love to hear from them. If you live in her constituency, South Northamptonshire, please email us.

The Minister confirmed that the FCA is ‘considering all avenues by which investors might be compensated’ as well as looking into allegations that Capita Financial Managers Limited set up and operated the Fund in a negligent fashion, that it failed in its duties under FSMA (the Financial Services and Markets Act 2000) and that the information memorandum and quarterly Fund reports that it issued may have been fraudulently misleading.

While she did not spell out the fact that the Fund and investors could soon launch civil actions against Capita, its directors and other employees or anyone else, Ms Leadsom confirmed that litigation is an option and indicated that there is some urgency to this, because although we would argue that the statute of limitations gives us three years from the date that we became aware of problems to issue proceedings, there is a small risk that Capita might try to argue that we have six years from the date that the wrongdoing began.

With this in mind, any investor who has not yet completed his or her assignment of claim is strongly advised to do so immediately. If you have not received the paperwork, a link to the relevant email address can be found in the Action Points section at the end of this blog.

Ms Leadsom had clearly been briefed on the case by the FCA, so should be forgiven for repeating in good faith some of the half-truths habitually trotted out by that organisation in its defense, especially those relating to the adequacy or otherwise of its actions after George Patellis blew the whistle in January 2011 and the astonishing leniency with which it treated Capita after losses were discovered in another scheme it ran, namely Arch Cru. A volunteer for the Action Group has written to the Minister setting the record straight and requesting a meeting. We will update you on whether or not one is granted.

Investors based in the UK can watch footage of the debate here and here (click on Alun Cairns to the left to skip to the relevant footage).

The above links may not work for those based abroad. Alternatively, the full transcript can be viewed on Hansard here.

INVESTOR WARNING: CAPITA PLC (LSE:CPI)

We are aware that many investors in the Connaught Income Fund Series 1 subscribed to the scheme with money held in pension schemes, especially SIPPs (Self-Invested Personal Pensions). Many such investors also hold shares in dividend-paying FTSE100 companies, including Capita plc. If so, we think they should consider selling their Capita shares.

The cost to Capita of buying investors’ positions in Connaught at the price we paid, plus perhaps two and a half years’ missed income distributions and any consequential losses, less the distributions made since suspension in March 2012, is likely to approach £120m. We doubt that the highly geared firm can achieve this without suspending its dividend. This is likely to have a negative impact both on the share price and on investors who rely on the company for income.

We believe this is the least bad outcome for Capita shareholders. Once the firm replaces investors as the Fund’s principal creditor, it will benefit from the proceeds of the liquidation, such as realisations from the loan book and settlements from the various professional services firms whose negligence contributed to the losses, less the liquidators’ and legal costs. These recoveries could eventually result in Capita receiving a significant proportion of the compensation back onto its balance sheet.

Shareholders should, however, also consider the prospects of the firm in the event that the FCA does not issue the desired restitution order and the management team chooses not settle voluntarily.

Some of the matters over which claims could be brought could result in Capita being barred from competing for future public sector contracts. These represent much of the company’s revenue.

Furthermore, the group might, unwisely, replay the argument it used in 2009 to escape meeting the full costs of its negligent management of another investment scheme, Arch Cru, when it claimed that the subsidiary holding the contract (and also operating and promoting the Connaught scheme), Capita Financial Managers Limited, had a weak balance sheet and insufficient insurance to meet the claim, and argued that if the regulator issued a restitution order, the parent would simply place the subsidiary in administration and walk away.

We suspect that if investors got even the slightest whiff of this argument being raised this time round, City journalists would be briefed and the news would be circulated to the group’s biggest customers. Aware that the parent was not willing to place the resources of the group behind its subsidiaries, prudent clients would have no alternative but to terminate contracts and switch to other, more secure suppliers. The consequences of such a loss of business could be catastrophic, especially given the group’s high level of gearing.

Also, Capita currently has 16 subsidiaries registered with the FCA able to undertake financial services activities. The regulator would have to review whether these, like CFM, were under-capitalised and under-insured and hence unable to continue trading without a significant injection of capital or the purchase of additional insurance. It would also have to consider whether, given the concealment at group level of the Connaught problems, the group was unfit, as a result of its deficient culture and governance, to operate at all in the area of regulated financial services.

Finally, there is a risk that litigation could be brought against some of the employees and directors who were party either to misleading investors or to withholding from us material information. It is unlikely that those individuals collectively would have the resources to meet such a claim, which could result in their bankruptcies. Given that undischarged bankrupts cannot serve as company directors, there is a risk that directors of the plc and some key subsidiaries could be compelled to resign, just as the company is fighting the catastrophic, self-inflicted problems outlined above.

There is, fortunately, good alignment of interests between investors, the FCA, Capita’s management and the group’s shareholders: they are all better off if the FCA issues a full restitution order, and Capita accepts it gracefully. This would enable the FCA to redeem itself for its and the FSA’s many failings in respect of Connaught and to position itself as a capable and rigorous regulator, unafraid, under its new name and Chief Executive to hold a large firm to account for its failings. Capita’s directors would not face claims against themselves personally, and while there might be an expectation for those who caused or concealed the problems to leave the business, they could at least do so with their finances intact and able to seek employment and directorships elsewhere. Capita itself would not face a catastrophic loss of contracts, though we would hope that the FCA would in due course review the finances, insurance and culture of its regulated subsidiaries, and change would be needed to prevent another Arch Cru or Connaught from occurring. Shareholders’ losses would be limited to the cost of compensating Connaught investors, plus perhaps a modest reduction in income or return on equity from financial services in the future as a result of a review by the FCA.

Most important, investors would be put back in the position they would have been in had Capita bothered to do even the most basic due diligence before agreeing to promote the Fund. That, surely, is not an unreasonable expectation.

We very much hope that all those concerned see the benefits to doing the right thing. In the meantime, we’re sellers of Capita stock.

ACTION POINTS

If you have not yet returned your completed assignment of claim form to Duff and Phelps, it is ESSENTIAL that you do so RIGHT AWAY. We really cannot overstate the importance and urgency of doing this. Not only does it increase the amount of money that can potentially be claimed from those who are responsible for our losses, but it also adds enormously to the leverage that we have over those people, and the FCA, when demanding a restitution order or voluntary settlement.

Should you not have received the necessary paperwork, or if you require help or advice before completing it, please email Duff and Phelps RIGHT AWAY. PLEASE DO IT NOW!!!!!!!!!!

If you live in Andrea Leadsom’s South Northamptonshire constituency, we at the Action Group would like to hear from you. Please email us.